Today we’ll look at Cadsys (India) Limited (NSE:CADSYS) and reflect on its potential as an investment. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
How Do You Calculate Return On Capital Employed?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
Or for Cadsys (India):
0.20 = ₹103m ÷ (₹710m – ₹106m) (Based on the trailing twelve months to September 2018.)
So, Cadsys (India) has an ROCE of 20%.
Does Cadsys (India) Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Cadsys (India)’s ROCE is meaningfully better than the 14% average in the IT industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Cadsys (India) compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Cadsys (India)’s current ROCE of 20% is lower than 3 years ago, when the company reported a 39% ROCE. This makes us wonder if the business is facing new challenges.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. You can check if Cadsys (India) has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Cadsys (India)’s ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Cadsys (India) has total assets of ₹710m and current liabilities of ₹106m. As a result, its current liabilities are equal to approximately 15% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
The Bottom Line On Cadsys (India)’s ROCE
Overall, Cadsys (India) has a decent ROCE and could be worthy of further research. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
But note: Cadsys (India) may not be the best stock to buy. So take a peek at this free list of interesting companies with high ROE and low debt.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.